How to Improve the Net Operating Income (NOI) of Your Buildings
If you have been working in real estate for even a little bit, you probably have already heard the term Net Operating Income (NOI). While you may be familiar with the term, do you know what it actually is? More importantly, do you know how to actually improve it?
Whether you are new to the commercial real estate industry, transitioning into a new role, or just looking to refresh your knowledge, we got you covered. Let’s take a look at what Net Operating Income is, why it matters, and a few ways you can start improving it.
What is Net Operating Income (NOI)?
To put it simply, NOI is a benchmark used to measure the profitability of a building or portfolio. NOI is meant to get down to brass tacks and provide a quick snapshot on whether a building is worth continuing to own and maintain.
Net operating income is just one metric used by investors, portfolio managers, and asset managers to determine how valuable property is and when they should buy or sell. For example, NOI is used to determine the CAP rate which provides a benchmark for the amount of risk in a certain asset.
How to Calculate your NOI
Figuring out the NOI of your building(s) is not that difficult. Before you start, you are going to want to compile two numbers.
Revenue generated from buildings – How much money does the building and property bring in in rent, parking fees, and other income sources. For other industries, you should ensure you remove services fee or other sources not directly related to the building and property.
Operating expenses from buildings – How much does it cost to maintain the building, including property taxes and insurance. This number really gets at the quality of the building and how well it is being maintained. It should be noted that capital investments do not get included in this number.
There isn’t a set standard for a “good” NOI, just like mothers “don’t” have a favorite child. This number provides a baseline to compare your building or portfolio to similar ones in your area. So while a number by itself doesn’t tell you good from bad, by doing a bit of comparison research you can get a clearer picture on the value of your building. Factors such as industry, location, and age will affect your actual NOI number and should all be considered for comparisons.
If you are an investor, NOI can provide one data point as you decide what properties to buy and which to sell. When looking to purchase, it is important to verify the data and numbers you receive on properties as NOI can be manipulated slightly depending on what maintenance has been deferred or prioritized. This is not the recommended way to improve the NOI of the buildings and portfolios you are managing.
How to Improve NOI
Let’s say you are in charge of managing a building or portfolio though and your NOI numbers aren’t what you want them to be. Improving NOI starts with taking a look at how your buildings are being operated and maintained today. Better quality buildings not only have less maintenance, especially emergency maintenance that can be costly, but with a higher quality building you can charge more per sq. ft.
To get a sense of how things are working today, start by talking with your building operators and facilities teams. If they are utilizing a facility management software, you should be able to get baseline data around the maintenance work they do on a daily basis. One thing to consider in terms of the maintenance of your buildings is looking at how much preventive maintenance is happening. While preventive maintenance does require a small upfront investment, it allows your teams to stay ahead of breakdowns and extend the useful life of facility assets which saves money in the long run.
Deferred maintenance is another area that with small initial investments, can greatly improve the quality of your buildings and their NOI. Chances are your teams have a long list of deferred maintenance that they haven’t been able to get to due to budget restraints. These tasks often aren’t costly alone, but as that list gets longer it leads to more fixes and more breakdowns which add to your maintenance expenses.
The last area you should look at for improving the quality of your buildings is what capital investments are needed in your buildings. While these renewals or replacements are costly one-time expenses, they don’t count in your NOI calculation and the long-term cost savings can be enormous. When a facility asset like the HVAC system or a water heater is old and in poor condition, it runs sub optimally which can add hundreds of dollars a month to your utility bills. Knowing what capital investments are upcoming and which pose the highest risk is vital to spending your money wisely and getting the most bang for your buck.
Better NOI Starts With Better Capital Planning
If your NOI isn’t where you or your investors want it to be, it isn’t the end of the world. A few small steps and upfront investments can go a long way to improving that number and the overall value of your buildings and portfolio. If you are looking for more insights, check out our latest eBook “The Future of Capital Planning: IoT, Big Data, and AI” to see how you and your building operators can start better allocating money and improve the NOI of your buildings.
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